3/11/2011 @ 5:09PM11,365 views

Why Social Security is a Ponzi Scheme

Want a recipe for ruckus? Merely suggest that Social Security might be a “Ponzi scheme”. You might even end up on Drudge Report. Yet the facts bear out the thesis, as we shall see…

For starters, let’s be clear on what a Ponzi scheme is.

Charles Ponzi -- Image via Wikipedia

Say you’re in a scheming kind of mood and looking to get rich off it. Say you’re Bernie Madoff! You start by convincing a small group of people, say five of them, to each give you some money, say $1,000, with the promise that each month thereafter, you’re going to give them $50 back. That works out to $600 over the year, or a 60% rate of return. Not too shabby! These people are a little skeptical at first, but the promised 60% rate of return seems worth the risk. So you collect $5,000, but pay out $600 to each of these five people, $3,000 in total, leaving you ahead by $2000 at year end. So far so good — stick with me…

Here’s how you’ll fund the $3,000 you’re going to pay to those five people.

Not long after the first five, you find ten other people to also give you $1000, with the promise that they, too, will get $50 back each month thereafter. You take in $10,000, and over the course of the year, you pay back the $3,000 to the first group of five people, leaving you with $7,000 from the group of ten, plus the full $5,000 from the group of five, for a total of $12,000. But you still owe the group of ten $6,000. That’s OK, because after you pay them, you’re still ahead by $6,000.

You can repeat the same funding mechanism to pay back that group of ten. Find another ten people, or ideally, more than ten, promise each of them $50 a month, and pay them by using the incoming cash from yet another group of people. Keep this going for a while and all the people earning 60% a year on their money might even turn you on to their friends. It almost seems like a virtuous circle.

All the math for this will work out great provided you play by some simple rules. You absolutely must keep finding more people to pay in. You might need to start promising a lower return to new “investors”, just to help the math. Oh, and you’ll want to keep everyone in the dark about what’s really going on.

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